One of the longest-running myths in financial markets is going to damage a lot of portfolios: the myth that central bank money printing — in the context of a modern banking system — hikes the value of stocks.
Many academics still think printing lots of money — which is thought to permanently increase stock prices — will lead to some sort of trickle-down economy phenomenon. Ben Bernanke said as much in his famous November 2010 Op-Ed in The Washington Post: “Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
Since then, the S&P 500 has rallied from 1,200 to 1,430, mostly on the belief that stocks are a good substitute for bonds. Printing from the Fed and other central banks has front-loaded returns. Front-loading returns means the potential market gains will be depressed. In other words, the Fed’s actions have temporarily pushed stock prices above intrinsic value, and when the Fed stops money printing, stocks could quickly fall back to intrinsic value.
Yale professor Robert Shiller created the “Shiller P/E ratio,” which is the most-robust measure of the intrinsic value of the broad stock market. The Shiller P/E ratio is calculated as follows: Divide today’s S&P 500 index by the average inflation-adjusted earnings from the previous 10 years. I look at 10 years of earnings and cash flow data in researching stocks to get a feel for how earning might look in the future. Most investors remain too focused on the quarter-to-quarter minutiae, which often leads to surprises at turning points in the earnings cycle.
The Shiller P/E of the S&P 500 is currently 23 — 50% higher than its long-term average. The average Shiller P/E ratio since 1880 is about 15. A move back to the average would take the S&P 500 back to 930. A move to bear market low valuations would take the S&P 500 back to roughly 400. Right now, it’s 1,432.
The Fed can’t grow the intrinsic value of stocks. Companies can do that only by earning returns above their cost of capital.
In the coming quarters, many companies that had been earning returns above their cost of capital will be earning lower returns. Free cash flow will follow returns lower. Look at Intel’s latest revenue warning; look at FedEx’s earnings warning. Profit margins have peaked in many industries. Manufacturing companies exporting to Europe and China will continue to suffer. Apple can hold neither the stock market nor the economy up.
Meanwhile, household budgets out in the real world are straining to the breaking point. This morning’s data showed the US labor force participation rate at a terrible 63.5% — the lowest in 31 years.
So Ben Bernanke is responding to this silent crisis the only way he knows how…by pushing repeatedly on the “print money” button at the Federal Reserve. He calls is “quantitative easing,” or QE. And it’s my bet that QE3 is coming soon to a nation near you. With each successive round of quantitative easing, demand for gold and other stores of value will rise and demand for stocks will weaken.
As I observed in this column last Friday, “Fed officials have been all over the media for weeks, laying the groundwork for a third round of quantitative easing. By preparing markets for QE3, the Fed refuses to let real-world evidence get in the way of its beloved theories…Perhaps once the global paper money system is restructured, involving some sort of gold standard, sanity will return to the Fed and other central banks. Until we see more signs of sanity, hold a core position in gold, silver, and precious metal mining stocks. These asset classes will be the prime beneficiaries of future printing.”
Dan Amossfor The Daily Reckoning
Dan Amoss, CFA, is a student of the Austrian school of economics, a discipline that he uses to identify imbalances in specific sectors of the market. He tracks aggressive accounting and other red flags that the market typically misses. Amoss is a Maryland native, a graduate of Loyola University Maryland, and earned his CFA charter in 2005. In spring 2008, he recommended Lehman Brothers puts, advising readers to hold the position as the stock fell from $45 to $12. Amoss is our macro strategist and guardian of The 5 Min. Forecast PRO.
“the Fed refuses to let real-world evidence get in the way of its beloved theories…”
what do you mean by “beloved theories”? you mean the stuff they tell US?
“Until we see more signs of sanity, hold a core position in gold, silver, and precious metal mining stocks.”
ever heard of precipitation?
“when the Fed stops money printing, stocks could quickly fall back to intrinsic value.”
I think there’s a problem with your premise.
Gold is the most manipulated commodity on earth. Just as paper money is. Come on come up with a better concept of what money is.
Right now, health care makes up about 25% of the federal budget. A scary statistic to be sure... But here's an even scarier one: health care's portion of the federal budget doubles roughly every 20 years. Yikes! Addison Wiggin explains why this is and what needs to change to prevent health care from taking up half the federal budget. Read on...
Is your government too big? Find out in today’s Laissez Faire Today with six “red flags” to look out for. Chris Campbell covers everything from one ObamaCare whistleblower to the strange case of our new Ebola czar. Read on…
McDonalds stock is getting crushed right now. Shares have been in a tailspin since June. But it’s not just Mickey Dee’s. Coca Cola shares are in freefall, too. Bad news for them. But if you want to rake in a pile of easy money, it could be great news for you. See, Americans just aren’t choking down this junk like they used to. The fast food burger, fries and a Coke are just down payments on an early coronary - and Type II diabetes. And everyone’s finally gotten the message. So how can you play the trend? Greg Guenthner explains…
Panopticon goggles? Severe market panic in 2018? Gold confiscation by 2020? Jim Rickards' shocking thought-piece in the spirit of A Brave New World or 1984. Click to see how markets, economics, your money, gold, privacy, wealth building and more look a decade from now in the year 2024...
I believe we are in the midst of one of the greatest profit opportunities you’re ever going to see in your lifetime. Stop listening to what the government is telling you. Turn off CNN. Forget what you see on the news. And for God’s sake, forget about the market crashing. Right now, we are in the early innings of the greatest profit opportunities of the 21st century. A biotech boom that’s about to hit epic proportions thanks to Ebola. If I’m right, we are going to see Ebola in New York, Los Angeles, San Francisco and Miami. And when this happens, every single stock that has anything to do with Ebola is going to soar. Let me explain to you how I believe this huge Ebola bubble is going to unfold.